Measuring price-deflation in a free market

Static4367 · Subject: Re: Measuring price-deflation in a free market Sun Jun 14, 2009 6:57 pm

Conrad, you are completely correct, I badly muffed my example, which was completely inconsistent with the explanation thereafter. Using a physical good (usually the reciprocal side of the relationship) as the currency had my thought process all mixed up. Danny is certainly a pro for being able to pull the critical point out of that mess, and I think he clarified the point well so I won't belabor it.

Danny wrote:

And it also seems like we'd run into a serious public goods problem: everyone's money's purchasing power would rise from economic growth, and investments would be necessary to facilitate economic growth, but the investors would have no way of capturing the full value of their investments. Accordingly, there would be chronic underinvestment.

This gets at why I previously said that in a free market people would away from a deflationary good as the currency. In the environment you describe economic growth would slow to keep economic output in line with the money supply. In a free market though, opportunists would form contracts in alternative goods.

As another important distinction we should separate the currency of exchange from the form in which value is stored. As you stated previously, people would be more than willing to store value in a deflating currency, and in fact that is what they do by shifting their savings out of money deposits and into assets that gain value over time.

NonEntity wrote:

Danny Shahar wrote:

The thing is, though, there's an important sense in which printing new money is like...well I dunno...stealing or something. Right? I mean, who gets the new money? Who gets to decide how much new money is printed and what it gets used for? Why should they get to consume everyone else's products without contributing anything to the economy except printing a bunch of notes?

Indeed!

I don't see why people find this so hard to get. Fiat money is fraud, pure and simple. It is theft of value no different than any other form of counterfeit goods. If I water down a gallon of milk it is no longer a gallon of milk. It is a part of a gallon of milk and a bunch of water. Same with fiat money. It may look like milk and it may taste like milk, but if you keep on diluting it over time you will have the same situation as we have now with the value of a dollar. There's no beef. (reference to an old Wendy's commercial)
- NonE

The problem I have with this NonE is that you are conflating two different terms. The fraud exists in the lack of transparency in Federal Reserve behavior and the laws that prevent people from transacting in other currencies (note as above that storing value in other goods and currencies is perfectly legal and prevalent).

Fiat money in the sense of representing the future value of some asset or group of assets with a written declaration is not fraud at all and inflating the supply of those declarations transparently is not fraud either. If I buy stock in GE, is it fraud when GE issues new shares to raise capital, thereby diluting my ownership? Not at all. I bought a share of company and was provided access to information on its current financial state with the understanding that it might need to raise capital in the future. The fraud with Fiat money is that there is no transparency with regard to what we own shares in and we are forced to use it even though many of us would probably prefer a more transparent alternative.

Danny wrote:

As a side note: is it just me or are people feeling like this is rather Keynesian?

Not sure I like the term Keynesian because most schools of economics focus on monetary issues to the point of obfuscating the underlying reality. It is very focused on the nominal rather than the real though.

Conrad · Subject: Re: Measuring price-deflation in a free market Sun Jun 14, 2009 7:02 pm

BUMP

Quote:

In a deflationary environment economic activity grinds to a halt precisely because everyone knows their money will be worth more in the future than anything they might spend it on or invest it in now.

same thing with computers nowadays no? nobody is buying computers because they will get cheaper all the time, and so the computer industry is dying down.

oh wait...

sorry. is this an inappriopriate comparison though? If so, why? how does the comparison not work?

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Conrad · Subject: Re: Measuring price-deflation in a free market Sun Jun 14, 2009 7:13 pm

Danny Shahar wrote:

Conrad, if I understand it correctly, I think that Static's point can be seen like this:

In a consistently deflationary economy, a person's purchasing power would increase over time simply for holding money.

and the holding of money would contribute even more since it takes money away from the economy, thereby increasing the purchasing power of the currency that is in the economy. and once the hoarder starts to spend it he is the first and can still profit from the old purchasing power before the effects of his money entering the economy have decreased its purchasing power.

(so there's a tendency to hoard and as a result also a tendency to spend (before others do), all in the same person)

Quote:

This would mean that individuals would have some incentive to hold their money instead of investing it.

why? the question is: is a specific investment a better way to increase my wealth than my holding the money and waiting instead? the fact that the latter is more attractive in a deflationary economy than in a deflationary one in itself is not very relevant for the former question as long as no argument has been made about how investment is generally affected by a deflationary rather than an inflationary economy.

Quote:

In an inflationary economy, on the other hand, people are constantly losing purchasing power by holding money. There is therefore an incentive to convert monetary instruments into non-monetary investments in order to protect oneself from inflation.

yes. but surely investing is not a good thing per se. the incentives indeed change re hoarding and re investing as a result of inflation. but it is of course not the case that the more you invest the richer you become. What matters is the level of savings and the demand for whatever you're investing in. So arguments should concentrate on that

Quote:

Static's contention appears to be that people would hold money instead of investing in a deflationary economy, and this would hinder economic progress.

but why, why would there be fewer of the good investments

Quote:

I'm not sure what I think of this. It seems to me that even though the price of a firm's products would be going down over time, the same would be true of the prices of its inputs.

yes

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As long as outflows exceeded inflows, it seems like businesses could still be profitable. And profitable businesses would still be worth investing in.

yes

Quote:

But it also seems true that in a deflationary economy there is a positive incentive to hold money that does not exist in an inflationary economy.

oh yes

Quote:

ake it pretty difficult for any business venture to get off the ground.

I think you assume too much there ('pretty difficult' rather than 'more difficult') and you lose sight of the other essential factor, namely the eventual and sustainable profitability of the investment once launched. if inflation affects that negatively and deflation affects that positively, then your point wouldnt hold

Quote:

And it also seems like we'd run into a serious public goods problem: everyone's money's purchasing power would rise from economic growth, and investments would be necessary to facilitate economic growth, but the investors would have no way of capturing the full value of their investments. Accordingly, there would be chronic underinvestment.

how is this different right now re investment: investment already creates greater purchasing power for everybody than there would have been without it?

Quote:

The thing is, though, there's an important sense in which printing new money is like...well I dunno...stealing or something. Right? I mean, who gets the new money? Who gets to decide how much new money is printed and what it gets used for? Why should they get to consume everyone else's products without contributing anything to the economy except printing a bunch of notes?

I do. Because I care.

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Static4367 · Subject: Re: Measuring price-deflation in a free market Sun Jun 14, 2009 8:28 pm

Conrad wrote:

BUMP

Quote:

In a deflationary environment economic activity grinds to a halt precisely because everyone knows their money will be worth more in the future than anything they might spend it on or invest it in now.

same thing with computers nowadays no? nobody is buying computers because they will get cheaper all the time, and so the computer industry is dying down.

oh wait...

sorry. is this an inappriopriate comparison though? If so, why? how does the comparison not work?

I do think it is an inappropriate comparison because people do not use computers as a means of exchange. When I buy a computer I intend to own it for the remainder of its useful life. Not so with money. I "buy" money only so that I can get something else for it in the future.

In reference to all the points in your other post:

I don't want to get trapped playing the devil's advocate just to save face. I think many of your points are valid. I am confident that the market could account for slow, predictable deflation adequately just as it accounts for predictable inflation adequately.

My original point was that in a free market people would not choose to use a deflating asset as a unit of exchange (as opposed to as a store of value). This is essentially Gresham's law. If market participants were free to choose, they would hold the stuff that they expect to gain in value and exchange the stuff that they expect to lose value.

As I am writing this now it occurs to me that this a very reasonable explanation for why there is so little competition for sovereign currency. Even people who promote gold as currency would be crazy to use it in exchange if they can get the same goods in exchange for dollars that they expect to become worthless. As such the free market has devised a bazillion ways to invest (store) value but essentially none to exchange it. Note that many people do in fact invest in gold and use it as a store of value but choose not to use it in exchange, so it is not for lack of supply or access that people do not use gold as currency.

NonEntity · Number of posts: 2594 Registration date: 2007-11-08

Static4367 wrote:

Fiat money in the sense of representing the future value of some asset or group of assets with a written declaration is not fraud at all and inflating the supply of those declarations transparently is not fraud either. If I buy stock in GE, is it fraud when GE issues new shares to raise capital, thereby diluting my ownership? Not at all....

Actually, as far as I am concerned it IS fraud. It may not be "legally" fraudulent, but it is ethically.

Quote:

I bought a share of company and was provided access to information on its current financial state with the understanding that it might need to raise capital in the future. The fraud with Fiat money is that there is no transparency with regard to what we own shares in and we are forced to use it even though many of us would probably prefer a more transparent alternative.

That's because you are owning shares in NOTHING. There is nothing backing up fiat money. NOTHING. (Aside from the ignorance of those who believe that there is.)

- NonE

Static4367 · Subject: Re: Measuring price-deflation in a free market Mon Jun 15, 2009 1:16 am

NonEntity wrote:

Static4367 wrote:

Fiat money in the sense of representing the future value of some asset or group of assets with a written declaration is not fraud at all and inflating the supply of those declarations transparently is not fraud either. If I buy stock in GE, is it fraud when GE issues new shares to raise capital, thereby diluting my ownership? Not at all....

Actually, as far as I am concerned it IS fraud. It may not be "legally" fraudulent, but it is ethically.

I don't see how you can make this claim. An individual and a corporation, by mutual consent, make an agreement with certain terms and conditions. How can this constitute fraud, ethically or otherwise, if the mutually agreed upon terms of the contract are not violated?

It just seems you are weakening a strong argument by extrapolating the point too far.

Conrad · Subject: Re: Measuring price-deflation in a free market Mon Jun 15, 2009 4:36 pm

Static4367 wrote:

Conrad wrote:

BUMP

Quote:

In a deflationary environment economic activity grinds to a halt precisely because everyone knows their money will be worth more in the future than anything they might spend it on or invest it in now.

same thing with computers nowadays no? nobody is buying computers because they will get cheaper all the time, and so the computer industry is dying down.

oh wait...

sorry. is this an inappriopriate comparison though? If so, why? how does the comparison not work?

I do think it is an inappropriate comparison because people do not use computers as a means of exchange. When I buy a computer I intend to own it for the remainder of its useful life. Not so with money. I "buy" money only so that I can get something else for it in the future.

yeah, but I thought your point was that deflation is bad because stuff keeps getting cheaper so that people will hoard rather than spend or invest money. Then the computer industry in which there is continuous deflation but which seems to be thriving and people buy lots of stuff even though they can get it for much cheaper a year later, seems to belie that claim.

Ain't I right, folks? Huh? How about it?

Quote:

In reference to all the points in your other post:

I don't want to get trapped playing the devil's advocate just to save face. I think many of your points are valid. I am confident that the market could account for slow, predictable deflation adequately just as it accounts for predictable inflation adequately.

okay, but then I probably misunderstood you before, cuz I thought you were arguing the opposite

Quote:

My original point was that in a free market people would not choose to use a deflating asset as a unit of exchange (as opposed to as a store of value). This is essentially Gresham's law.

but Gresham's Law is a law of price controls: through legal tender laws governments overvalue one currency and hence undervalue another so that the latter leaves the country and the former comes in. In the analogy the deflating currency would leave the country in your view, but why? i don't see how the same principle s in Gresham's Law holds in the case of a deflating currency.

Quote:

If market participants were free to choose, they would hold the stuff that they expect to gain in value and exchange the stuff that they expect to lose value.

ah okay, so then it wouldnt be that a currency moves out of the country but that people would hoard it, and in that sense it would be 'driven' away for being good. But I wrote before that there certainly may be a tendency to hoard the money but also a counteracting tendency to spend it (because it will be worth more and you have to 'cash' your profit at some point, and because you'd profit from the old exchange rates before the new level is reached that was caused by your using the money again.
Also, let's reverse the situation: for a transaction you need a buyer and a seller of money. In deflation as you said it can be argued that the seller of money will want to wait. But the buyer would want to buy it. And an equilbirum price will be found.
moreover, in an inflationary situation people want to get rid of their money faster, they want to be seller, but on the other side of the transaction: why would people want to buy that money? So then your conclusion might be: nobody wil, ever buy the inflationary asset. But clearly here too an equilibirum would be found.

also, in the 19th century there was deflation and I don't think gold lost its status as the universal medium of exchange.

Quote:

As I am writing this now it occurs to me that this a very reasonable explanation for why there is so little competition for sovereign currency. Even people who promote gold as currency would be crazy to use it in exchange if they can get the same goods in exchange for dollars that they expect to become worthless.

but re the other side of the transaction

Quote:

As such the free market has devised a bazillion ways to invest (store) value but essentially none to exchange it. Note that many people do in fact invest in gold and use it as a store of value but choose not to use it in exchange, so it is not for lack of supply or access that people do not use gold as currency.

But this is Gresham's law, legal tender laws for dollars, and also likely a lot of restructions on using gold as money

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Static4367 · Subject: Re: Measuring price-deflation in a free market Mon Jun 15, 2009 8:22 pm

Conrad wrote:

yeah, but I thought your point was that deflation is bad because stuff keeps getting cheaper so that people will hoard rather than spend or invest money. Then the computer industry in which there is continuous deflation but which seems to be thriving and people buy lots of stuff even though they can get it for much cheaper a year later, seems to belie that claim.

Ain't I right, folks? Huh? How about it?

My point was that the future value of a computer is irrelevant because you don't ever intend to sell it, you are only concerned with its functional value. I only care about the future value of money because I intend to exchange it in the future and it has no functional value whatsoever. If I needed an asset to use as a store of value or a unit of exchange I would never use computers precisely because they depreciate too quickly.

Conrad wrote:

ah okay, so then it wouldnt be that a currency moves out of the country but that people would hoard it, and in that sense it would be 'driven' away for being good.

Yes, I am not making any reference to geography only usage in circulation. Deflating (appreciating) currency would come out of circulation because people would hoard it while choosing to exchange other goods expected to depreciate.

Conrad wrote:

But I wrote before that there certainly may be a tendency to hoard the money but also a counteracting tendency to spend it (because it will be worth more and you have to 'cash' your profit at some point, and because you'd profit from the old exchange rates before the new level is reached that was caused by your using the money again.

This comment seems to be conflating previous changes with expected changes. I may want to cash out previous gains but I will hold on if I expect further appreciation in the future. I am not sure I follow the end of the sentence though so feel free to clarify.

Conrad wrote:

Also, let's reverse the situation: for a transaction you need a buyer and a seller of money. In deflation as you said it can be argued that the seller of money will want to wait. But the buyer would want to buy it. And an equilbirum price will be found.
moreover, in an inflationary situation people want to get rid of their money faster, they want to be seller, but on the other side of the transaction: why would people want to buy that money? So then your conclusion might be: nobody wil, ever buy the inflationary asset. But clearly here too an equilibirum would be found.

I agree an equilibrium price will be found but the question then of how that equilibrium price relates to the velocity of exchange I think is a much more complicated question that we are just scratching the surface of.

I want to reiterate again that I am not claiming that a deflationary regime would be unworkable if it were mandated. I am only claiming that it would be unlikely to arise organically if other options existed.

Conrad wrote:

also, in the 19th century there was deflation and I don't think gold lost its status as the universal medium of exchange.

Fair enough. Price stability is only one factor in this equation so it is certainly possible that the advantages of using gold outweighed any disadvantages of price instability. Or the deflation may have been less severe than the instability in other assets.

I should probably make my assumptions more clear since they are not necessarily shared. Going back to the first page of this thread we were talking about monetary effects in a world without gov't intervention. I associate such a world with the future, and I expect in the future that there will be many liquid and easily trade-able assets such that any characteristic of a potential currency can be considered on an "all else equal" basis.

NonEntity · Number of posts: 2594 Registration date: 2007-11-08

Static4367 wrote:

NonEntity wrote:

Static4367 wrote:

Fiat money in the sense of representing the future value of some asset or group of assets with a written declaration is not fraud at all and inflating the supply of those declarations transparently is not fraud either. If I buy stock in GE, is it fraud when GE issues new shares to raise capital, thereby diluting my ownership? Not at all....

Actually, as far as I am concerned it IS fraud. It may not be "legally" fraudulent, but it is ethically.

I don't see how you can make this claim. An individual and a corporation, by mutual consent, make an agreement with certain terms and conditions. How can this constitute fraud, ethically or otherwise, if the mutually agreed upon terms of the contract are not violated?

It just seems you are weakening a strong argument by extrapolating the point too far.

I guess I need to flesh this out a tad more. First off let me proclaim that I still feel that there is such a thing as morality and it is from that perspective that I am writing. (I know I may be wrong on this, but that is my perspective at this point.)

True, the "caveat emptor" thing pertains, so from that perspective (similarly to the one wherein there are no morals in play) you are probably correct.

But I believe that only in some circumstances, maybe, can this be truely fair (the dilution of existing stock holders by issuing more stock.) I can see where perhaps if the shares of new stock sell at exactly the current market value of the existing stock then there would be no dilution. But I don't think this is always the case. Also consider the granting of stock options. In this case the "compensation" (the stock options) may be vastly out of proportion to the value of the stock held by current "owners."

But I have a problem with fictional entities interacting in the real world. That is my biggest problem. Like governments and corporations (spawn of governments.) Fictionaly entities can do serious harm, even death, and no REAL entity is held responsible for this. Even if one is fired, that cannot undo harms. The concept of a corporation is morally bankrupt, in my view.

- NonE

Static4367 · Subject: Re: Measuring price-deflation in a free market Wed Jun 17, 2009 7:10 pm

NonEntity wrote:

But I believe that only in some circumstances, maybe, can this be truely fair (the dilution of existing stock holders by issuing more stock.) I can see where perhaps if the shares of new stock sell at exactly the current market value of the existing stock then there would be no dilution. But I don't think this is always the case. Also consider the granting of stock options. In this case the "compensation" (the stock options) may be vastly out of proportion to the value of the stock held by current "owners."

I still don't understand how this can be condemned morally, ethically, or otherwise if there is a mutual agreement with full disclosure. There are abundant examples of poor management but that is just part of the deal. Stock in companies with great management sells at a premium while the stock of companies with poor management sells at a discount. When you buy stock in a company you do so with the understanding that you are delegating authority to management and the quality of management is part of the investment decision.

NonEntity wrote:

But I have a problem with fictional entities interacting in the real world. That is my biggest problem. Like governments and corporations (spawn of governments.) Fictionaly entities can do serious harm, even death, and no REAL entity is held responsible for this. Even if one is fired, that cannot undo harms. The concept of a corporation is morally bankrupt, in my view.

- NonE

As I see it there are two distinct issues with "fictional entities": the method of organization appropriate for a given productive activity, and the legal standing of that organization.

With regard to the former I think it is indisputable that people need to organize into groups in order to achieve goals that couldn't be achieved individually. Furthermore, it is essential that these groups be allowed some degree of self governance in order to be able to internalize transaction costs.

With regard to the latter I think you could make an argument that the concept of Limited Liability as in LLC, should be revisited. This is really a topic for another thread, but I agree that individuals should not be able to hide behind the legal status of the corporation when certain damages are truly the result of individual action rather than emergent behavior.

NonEntity · Number of posts: 2594 Registration date: 2007-11-08

From Lila's place:

Quote:

“Corporation: An ingenious device for obtaining individual profit without individual responsibility.”

– Ambrose Bierce

Which reminds me of another quote which I will mangle: Government is a device for privatizing profit and socializing loss.

- NonE

NonEntity · Number of posts: 2594 Registration date: 2007-11-08

Static4367 wrote:

I still don't understand how this can be condemned morally, ethically, or otherwise if there is a mutual agreement with full disclosure. There are abundant examples of poor management but that is just part of the deal. Stock in companies with great management sells at a premium while the stock of companies with poor management sells at a discount. When you buy stock in a company you do so with the understanding that you are delegating authority to management and the quality of management is part of the investment decision.

You make a good argument, Static. I can't say that I have an ironclad response to you, but let me throw this out and you can try it on for size:

When making a contract it is generally considered necessary that value be exchanged, else the contract is considered null and void. It is also necessary that both parties understand the contract.

So in the case where the corporate leaders can issue more stock at their whim and pretty much make your investment worthless (while enhancing their own positions - I wouldn't have an argument if they simply did something stupid and destroyed ALL of the value of ALL of the stock), it seems to me that this sorta violates the idea of the exchange of value.

I also am wondering if stockholders are really fully cognizant of the ability of the mucky-mucks to make their stock worthless.

I know that this runs contrary to the caveat emptor theory of human interaction, and would not apply in a world where it is acceptable to bludgeon small children for a million dollars, but in a world where honesty and integrity are valued - I just have problems thinking that this passes muster.

- NonE (who is feeling really embarassed at how much like a fucking bleeding-heart liberal he is sounding...

)

Stewart · Number of posts: 1182 Location: Boston, MA Registration date: 2008-04-03

NonEntity wrote:

So in the case where the corporate leaders can issue more stock at their whim and pretty much make your investment worthless (while enhancing their own positions - I wouldn't have an argument if they simply did something stupid and destroyed ALL of the value of ALL of the stock), it seems to me that this sorta violates the idea of the exchange of value.

To Static's earlier point, though, this is well understood by investors. If you buy shares in a corporation, you can hardly claim that you weren't aware that your shares may someday be diluted by some amount. It's not a secret. It's not fraud. If it offends you, that's one thing, but it's just your personal sensibilities.

NonEntity wrote:

I also am wondering if stockholders are really fully cognizant of the ability of the mucky-mucks to make their stock worthless.

I suspect that many 401(k) and mutual fund investors don't understand the finer points of shares and bonds and the world of finance at large. But what can we say about that? Caveat emptor. If a person lightly invests his life savings in an enterprise which he does not understand, I would not suggest that he deserves to lose his money. But neither would I be surprised or terribly sympathetic if he did.

It's also not nearly as cut-and-dry as you make it sound. The Motley Fool has a good primer on stock dilution, and the different scenarios where it can be a positive or negative change for existing shareholders. Deception and fraud are exactly that, but they're not integral to the system itself.

ExyPhylo · Number of posts: 1180 Registration date: 2007-12-12

Stewart wrote:

Deception and fraud are exactly that, but they're not integral to the system itself.

Or are they?
Corporations will pay vendors 60 days or 90 days to make the company look more or less profitable. There is nothing illegal about that, but I would say it is a practice in deception. The amount of revenue coming in any time frame is measured against the amount of expenses and/or revenue going out. That snap shot, is not an accurate picture of that time frame, it is simply a picture. To me in essence it is a fraudulent picture and does not represent the true state of financial affairs.

Some do regard that as great management.

ExyPhylo · Number of posts: 1180 Registration date: 2007-12-12

Static4367 wrote:

With regard to the latter I think you could make an argument that the concept of Limited Liability as in LLC, should be revisited. This is really a topic for another thread, but I agree that individuals should not be able to hide behind the legal status of the corporation when certain damages are truly the result of individual action rather than emergent behavior.

I agree.

Individuals on occasion are by contract held accountable for some of their actions, however the "law" and "the contract" often collide.